Proposal to establish Bad bank and Development Finance Institution [DFI]

Source- The Indian Express

Syllabus- GS 3 – Indian Economy and issues relating to planning, mobilization, of resources, growth, development, and employment

Synopsis- Budget 2021 proposed the formation of bad banks to manage NPAs and DFI for raising funds.

Introduction

• In Union Budget 2021 -22, Finance Minister has proposed to set up an ARC (Asset Reconstruction Company)/AMC (Asset Management Company) for non-performing asset (NPA) management.
• Additionally, the government proposed a development financial institution (DFI). It will enable long-term funding worth Rs. 5 lakh crore in the next 3 years for infrastructure projects.

What is the purpose of setting an ARC/AMC?

The COVID-19 disruption has already created a lot of stress in the banking system. The banks already have a gross NPA of around 7.5 percent, which is expected to rise to 13.5 percent by September 2021.

Thus, setting up ARC/AMC proposed, to buy bad assets of commercial banks. It will sell these assets at a discounted price in the market. This institution is commonly known as a bad bank. Experts at bad banks attempt a resolution through a professional approach.

It will enable banks to focus on fresh loans and investments.  This will help clean up the balance sheets of commercial banks and thereby make available more funds for lending.

Challenges:

1. First, Moral Hazard – According to some experts, the formation of ARC/AMC can enable banks to continue reckless lending practices.
2. Second, Mobilizing capital – Finding buyers for bad loans in a pandemic hit economy will be hard.

What is the purpose of setting up DFI during Union Budget 2021-22?

Development Finance Institution [DFI] –The DFIs are organizations owned by the government or charitable institutions. They provide funds for infrastructure projects that are of national importance but may or may not conform to commercial return standards.

In Budget 2021-22, Development Finance Institution (DFI) has been announced with the following specifications.

• Capital base = Rs 20,000 crore
• Lending target = Rs 5 lakh crore in three years.
• Aim– The proposed DFI will be used to finance social and economic infrastructure projects identified under the National Infrastructure Pipeline (NIP).

Challenges:

The earlier generation of DFIs ran into the problem of financing. The retail deposit access was cornered by commercial banks and the availability of long-term financing without government guarantees was limited.

Way forward

• The formation of ARC/AMC works as a relief for banks hit by soaring bad assets and a sluggish loan off-take amid the pandemic.
• The economy needs infrastructure investments more than ever to help it overcome the damage induced by the Covid-19 pandemic.